Deadweight Costs and ACC

My column at Interest.co.nz this week took on the deadweight costs of taxation. Andrew Little rightly noted that ACC’s overcharging amounts to a payroll tax, and that that payroll tax deters useful economic activity. Economists call that the “deadweight” cost of tax: it’s the cost of a tax over and above the collected revenue. Treasury recommends that we add 20% to the cost of any government-provided programme to cover the deadweight costs of the tax needed to fund it, but it’s important to remember that the deadweight costs of tax increase with the magnitude of the tax: the 0.3 percentage point difference between what ACC does charge and what it should charge will have associated deadweight costs, but the deadweight costs of substantial income tax hikes would be more than proportionately higher.

From the column, but read the whole thing:

The estimates of the extra burden taxes impose on the economy are most applicable around small changes in tax, like the 0.33% charged by ACC. A larger tax hike would have more than proportionately higher associated expected deadweight costs. A decade ago, Professor John Creedy summarised economists’ rule of thumb on the issue: if the tax rate doubles, the deadweight cost of taxation quadruples.